Every time over the past several years when inflation expectations have eased significantly stocks have declined and credit spreads widened meaningfully. But not this time. We continue to side with the weakening macro backdrop and retain our tactical (short-term) short positioning in investment grade credit.

Mikkelsen looks at the idea that stocks and credit are getting artificially propped up because large-scale quantitative easing in the U.S. and Japan is pushing investors into U.S. risk assets regardless of any fundamental weakness:

That appears uncharted territory, as what we have seen in the past is that QE can work to push investors into risk assets when perceived to boost economic activity and thus create inflation. We have little evidence that QE alone can do the job, without being perceived to improve fundamentals. Thus, again, we expect the weakening macro backdrop to prevail. However, in the meantime the technicals are undeniably strong despite the lack of retail inflows to long and intermediate high grade bond funds. Clearly we are seeing foreign institutional investors – especially from Asia – moving into US corporate bonds. However, this process has been ongoing for at least a year and is unrelated to the expansion of Japanese QE.

In the end, Bof A says the U.S. economy looks strong enough to overcome its recent adversities and rebound in the second half of this year, but the present weak patch is surprisingly bad:

[T]he current slowdown in the economy is clearly worse than expected at this stage, as evidenced by the declining Economic Surprise Index…. Moreover, on top of surprising domestic weakness we are faced with a number of important external risks such as those emanating from North Korea and Europe. Thus if stocks and credit are counting on the economy to pull through the near-term challenges they must believe strongly in an underlying more independent source of growth – such as the housing market recovery. This is our view and the reason we position for higher interest rates in the second half of the year. However, still we expect credit spreads to widen in the near term.